A holding company is a corporation whose sole purpose is to own shares in other companies. The holding company does not engage in production or sales itself. Instead, it is a director or board of directors that controls enough stock in another company to permit it to control the company's policies. The main reason to form a holding company is for protection of assets and increased control of other companies.
Holding Company Example
An early insurance company sees tremendous success and would like to expand. The board of directors of that company would prefer to set up independent offices that are not reliant on them for day-to-day operational management. They elect to form an "agency," allowing each new office to set up relatively independent daily operations. However, they ensure at least 80 percent of the stock for each agency is owned by the newly created holding company. This assures the holding company maintains a majority when it comes time to vote on any company policy. It also assures the holding company owns enough of each agency's stock to qualify for benefits on taxes such as deductible dividends.
Investing in a Holding Company
Some holding companies own controlling shares in more than one type of corporation, agency or business entity. These companies may even aim to purchase large shares in successful corporations for the intent of controlling those corporations at a later date. Perhaps the most well-known holding company in the United States is Berkshire-Hathaway, which owns interests in diverse businesses worldwide. Managed by Warren Buffet, Berkshire-Hathaway does not itself engage in any production or sales. It simply purchases shares of other corporations. However, an investor can also purchase shares in Berkshire-Hathaway. This is a unique holding company model that allows the public investor to capitalize on the benefits of a holding company without having the large sum of money required to actually form this type of company.
Benefits of Holding Companies
In addition to offering opportunities for ownership in a diverse range of businesses, holding companies also offer asset protection for a number of Americans. For example, a very wealthy individual may own a number of different assets including businesses, real estate and other ventures. If the individual personally owns each of these assets, then he or she would be personally liable for the errors and exposures of each business. To remove this personal liability, the individual can form a limited liability company in the form of a holding company. The LLC will not engage in any business itself or on its own behalf. Instead, it will simply own a controlling stake in each of the other assets.
Holding Company Challenges
When investing in a holding company, you should be concerned with the financial strength of each underlying company as well as the holding company as a whole. This can make the option very complicated. For example, some holding companies will own over 50 other companies, some of which put out profitable reports this quarter and some of which did not. You may need to read the prospectus of each of these underlying companies to understand the true position of the holding company at large.